Congress Already Considering Improvements to Title III Crowdfunding

Although Title III equity crowdfunding finally, after much delay, has finally gone into effect this week, Title III itself and the related regulations adopted by the Securities and Exchange Commission have long been criticized for putting too much restriction on the companies that are likely to use Title III. However, members of Congress are already putting forward new legislation intended to address some of the widely-perceived shortcomings of Title III.

Congressman Patrick McHenry, a sponsor of one of the original bills that ultimately became the JOBS Act, has introduced the Fix Crowdfunding Act (H.R. 4855), which seeks to increase the utility of Title III equity crowdfunding and address some of the grey areas in the law and regulations, particularly where it comes to the responsibilities of the funding portals that will host equity crowdfunding offerings. Among the Fix Crowdfunding Act’s provisions:

Funding Cap: Title III currently limits companies to raising no more than $1 million in any 12 month period using equity crowdfunding (the cap is not exclusive to other exemptions, so companies can also raise additional money via Regulation D or Regulation A exemptions). The Fix Crowdfunding Act would raise the cap to $5 million in any 12 month period. 

Funding Portal Liability: Title III imposes liability for material misstatements or omissions on an “issuer” that cannot show that it could not have known of the misstatement or omission despite the exercise of reasonable care. However, in its regulations the SEC declined to clarify whether funding portals would be considered “issuers” for the purpose of misstatement or omission liability. As a result, funding portals are currently liable for any misstatements or omissions made by issuers that use their platform; it is specifically this grey area that has dissuaded crowdfunding sites such as Indiegogo and EarlyShares from setting up Title III platforms. The Fix Crowdfunding Act clarifies that a funding platform is not considered an issuer, and has no liability unless the platform itself makes a material misstatement or omission or knowingly engages in fraudulent conduct; under this scheme, in order to make a portal liable for an issuer’s misstatement or omission, a plaintiff would have to prove that the funding portal had knowledge the issuer’s misstatement or omission.

Section 12(g) Investor Cap: While the JOBS Act raised the cap on shareholders to 2000 (including 500 non-accredited shareholder) before a company triggers reporting obligations under the Exchange Act, and specifically directed the SEC to conditionally or unconditionally exempt shareholders who purchase in a Title III offering, the SEC chose to impose a condition on this exemption, providing that a company with more than $25 million in assets could not exempt crowdfunding shareholders from the 12(g) cap. The Fix Crowdfunding Act would overrule this condition.

Special Purpose Vehicles: Some platforms, such as AngelList and OurCroud, use special purpose vehicles as part of their fund-style investment process — individuals place their money in a SPV, which bundles investors’ money that is then invested in a startup. SPVs have the benefit of streamlining startups’ cap tables, as there is legally only one investor. The Fix Crowdfunding Act would remove the exclusion on SPVs. 

Testing the Waters: Finally, the Fix Crowdfunding Act would enable companies to “test the waters” — that is, to obtain non-binding investor interest in a potential equity crowdfunding offering without having to undertake the effort and expense of making the required regulatory filings with the SEC prior to soliciting interest.

The Fix Crowdfunding Act has been referred to the House Committee on Financial Services; keep an eye on the legislation to see if it makes it out of committee to the full House of Representatives.

Federal Trade Secret Law On The Way

While the three traditional pillars of intellectual property law — copyright, trademarks, and patents — are protected by federal law (although copyright and trademark do have some state law analogues), trade secret law has always been solely in the domain of state law. However, yesterday President Obama signed into law the Defend Trade Secrets Act, which would finally create a federal law protecting trade secrets. 

A trade secret is usually some sort of information, process, or know-how that gives a company a competitive advantage — think the formula for Coca-Cola, one of the most famous and longest-running trade secrets. Trade secrets are like patents, except where the information, process, or know-how must be published in a patent, trade secrets derive their value from the fact that they are not publicly known; moreover, whereas a patent expires and its information enters the public domain, trade secrets can exist as long as they can be kept secret (of course, that means once the secret’s out, trade secret protection is lost forever).

The law protects trade secrets by allowing trade secret holders to sue a party that steals, or misappropriates, a trade secret for monetary damages (and to continue to keep the information secret if has not been publicly released). However, companies have had to resort to state courts to bring such lawsuits, and with large multinational corporations increasingly relying on trade secrets, state courts are seen as an inadequate forum to settle such large companies’ disputes over trade secrets. Accordingly, the Defend Trade Secrets Act creates a federal civil cause of action for misappropriation of trade secrets. 

The impact of the Defend Trade Secrets Act may be minimal on startups and small businesses, which are often too small to put into place the protections and procedures for the safekeeping of trade secrets (because in a small company everyone generally has a need to know everything, which can make it difficult to compartmentalize and secure information) — startups often tend to focus their IP strategies on the traditional categories of copyright, trademark, and patents. But for those startups and small businesses for whom trade secrets are an integral part of their IP strategy, the Defend Trade Secrets Act gives an avenue to access the federal courts — which often move quicker than state courts and typically have judges more well-versed in IP law.

Yes, You Can Afford an Attorney! Part Two

Earlier this week I wrote an article discussing how entrepreneurs and small businesses can actually afford to hire an attorney at the critical early stages of their business venture by working out payment plans to cover the full cost of an attorney’s fee.

However, I wanted to touch on the subject of affording legal services again to address something I’ve noticed in my years of practice — most people have absolutely no idea how much an attorney costs. This is likely attributable to both the wide disparity in what attorneys, even ones in geographic proximity and with similar experience, charge, as well as the large degree of secrecy some attorneys place on their fees. This leads prospective clients to have wildly varying expectations of what an attorney will cost. In my experience, I’ve had prospective clients absolutely sink in their seats when they hear that the hours of work they’re going to need is going to cost more than $200 (probably not realizing that at that rate I’d be working at slightly above minimum wage!), while other clients have near lept out of their seats in joy upon finding out that the contract they need drafted isn’t going to cost thousands upon thousands of dollars. 

Perhaps this is reflective of people’s various financial states — when $200 is a lot of money (and I’m in that camp too!) and you know that lawyers are supposed to be “expensive” you may set your expectations accordingly; conversely, when you hear of big law firms charging $500 to $1000 an hour and budget accordingly, you may not realize that a smaller law firm or solo attorney typically doesn’t need to charge that, because they don’t have the overhead that a large firm does.

Nevertheless, also in my experience I’ve found that some prospective clients are nervous at the mere prospect of what an attorney will cost, and will break off communication before even getting to the money question. When speaking with prospective clients, I am open to any and all questions they have, but only rarely in my initial communications will a prospective client ask me to at least ballpark what my services will cost. I’m happy to do so, obviously putting down a big caveat that I can’t give a solid fee quote until I’ve had some discussions with the prospective client and had an opportunity to throughly think about the scope of the matter; moreover, the less information I know about the matter when I get asked to ballpark, the bigger the ballpark is going to be.

So if you’re initial conversations with an attorney, don’t be afraid to ask for a ballpark. Of course, depending on how early the conversations are, the attorney may not have enough information to give an estimate; also, there are certain kinds of legal matters that are simply not estimable, such as litigation or bankruptcy. It may also be easier for attorneys who work by flat fee to give an estimate, than lawyers who work by hourly fee. Finally, remember that an estimate is just an educated guess based on the attorney’s experience handling similar matters — your matter, due to various factors, may end up costing less or more, particularly if the scope of the matter changes.

(As a final aside note, please don’t ask to negotiate our fees. If you simply can’t afford the fee, as my previous blog post suggests, try to work out a payment plan. If an attorney wants to give a discount for a repeat client or to get a payment-in-full, that’s fine, but asking us to discount our fees simply isn’t fair to our other clients who paid in full.)

Yes! You Too Can Afford a Lawyer for Your Business!

It’s an unfortunate reality of starting a business that legal expenses can often cost several thousand dollars, depending on the amount of work that needs to be done. As a result, many entrepreneurs simply decide to avoid that financial pain by either ignoring the legal work that needs to be done (such as drafting up a formal agreement between your company and a client or supplier) or doing it yourself. Of course, if you’re unfamiliar with the legal processes of starting a business, you may miss critical steps in the process and leave your business and/or yourself exposed. As a result, any entrepreneur looking to start a business should consult with an attorney who can identify the legal steps that need to be taken and assist with any of those steps that the entrepreneur cannot do herself or himself.

“But what if I don’t have thousands of dollars to pay an attorney?”, you ask. Fortunately, most attorneys who work with entrepreneurs and small businesses are flexible enough to work out payment plans with you. For added financial certainty, you can also try to find an attorney that is willing to handle your matter by flat fee, so that you can plan out your payments before you hire the attorney. Typically, even with a payment plan you’ll be asked to pay at least a portion of the fee up front (either as a retainer for hourly-billing or a percentage of a flat fee) — this is for the attorney’s peace of mind, so that he or she has a little bit more confidence that you will ultimately pay the full fee. It also goes without saying that you should be on-time with your payments as well; you don’t want an attorney who has to spend time trying to get you to pay your bill, rather than being fully focused on the legal tasks at hand. By not paying, you also don’t want to burn your bridges with the attorney who’s helped you get started and is familiar with your business; if you need an attorney’s help down the road, that attorney is not likely to want to assist you if you’ve ducked out on a outstanding fee.

Most attorneys went to law school to help their clients; if we’re in the field of working with entrepreneurs and small businesses, we understand that money can be tight, but we still want to work with you to get your business started. So if you’re launching a new business venture, don’t avoid talking to an attorney simply because you think you can’t afford one — many attorneys are willing to help you set up payment plans in order to be able to afford their services

New “Exit” Securities Exemption In New Transportation Bill

 Last month, Congress passed a transportation bill called the Fixing America’s Surface Transportation Act (or FAST Act), signed into law by President Obama. However, buried in the bill was an addition to the Securities Act of 1933. The addition codifies an “unwritten” exemption from the registration requirement for the resale of securities, called “Section 4(a)(1-1/2)” because it combined the exemptions of both Section 4(a)(1), which exempted securities transactions by any person or entity other than an issuer, underwriter, or dealer, and Section 4(a)(2), which exempted transactions by an issuer not involving a public offering.

The new exemption, which is inserted into the Securities Act as Section 4(a)(7), exempts resales of restricted securities so long as the transaction meets several requirements: 

1) The securities must be resold to an accredited investors

2) There can be no general solicitation for the resale 

3) If the company that originally issued the securities is not subject to reporting requirements, then the seller and prospective purchaser must have access to reasonably current information about the company, including the equity structure, the directors and officers, and financial records

4) The seller is not a subsidiary of the issuer

5) Neither the seller nor anyone being paid in connection with the transaction is a bad actor as defined under Regulation D

6) The original issuing company is not a blank check, blind pool, or shell company 

and 7) The class of securities involved in the resale have been outstanding for at least 90 days prior to the transaction.

Section 4(a)(7) provides another statutory resale exemption, in addition to Rule 144, the traditional codified resale exemption. Section 4(a)(7) provides greater flexibility than Rule 144, including having no cap on the amount of securities that can be resold in any one transaction, no holding period for the seller to qualify with, no requirement to report the transaction, and most importantly, an preemption from state registration requirements pursuant to NSMIA. 

However, Rule 144 has benefits over Section 4(a)(7), including allowing resales to any person or entity, unlike Section 4(a)(7)’s requirement that the purchaser be an accredited investor. Moreover, securities resold under the Section 4(a)(7) exemption remain restricted securities, unlike in a Rule 144 transaction which unrestricted the securities.Therefore, a purchaser who acquires securities in a Section 4(a)(7) transaction must find an exemption if they wish to resell.